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Discover the Ugly Secrets of Buying REO's

Aug 1, 2008
With the foreclosure market in total chaos in many parts of the country, the popularity of investors buying REO (Real Estate Owned) properties is growing rapidly. The REO's are properties that lenders have taken back title from homeowners by foreclosure or a deed in lieu of foreclosure. These properties are then sold through realtors by way of listing on the MLS (Multiple Listing Service) or by bulk sales to real estate investors who purchase 20 to 100+ properties at a time.

For the average investor looking at getting a "good deal" buying a property, he will focus on foreclosures and in many cases doing a short sale on them. A short sale is where the lender will take a substantial discount off the amount owed on the property to sell quickly instead of going through a prolonged and expensive foreclosure proceeding and then listing the property and finding a buyer. A recent trend by lenders is to offer the homeowner a "short pay" amount which is similar to a short sale except the sale goes to the homeowner by a cash or financed purchase, but not with financing from the same lender. You might question, "If the homeowner is in foreclosure, how he can possibly buy his home back?" Ironically, it is not impossible for a friend or relative to loan him the money to buy back his property.

Let's look at another property that has been taken back by the lender by foreclosure or a deed in lieu of foreclosure. In this case the lender must put it in the hands of a local realtor, have it listed on the MLS, and hopefully sell it in a few months. That's the usually strategy, but a different approach is being taken by many realtors that could be construed as misleading to perspective buyers. In this case the lender may have an appraisal of one amount, assume $250,000, but the property needs some work. The next decision is to determine where to start pricing the property.

If the property is in good or better condition, the first pricing will be start at about 80% - 90% of Fair Market Value ("FMV") which is easily determined by the realtor from open listings. The lender may or may not make a profit at this level but will keep holding this initial pricing for 30 to 90 days. After this the lender will instruct the realtor to begin reducing the listing price by some percentage over a pre-determined schedule. For example, the property is originally listed for 80% of appraisal or BPO (if a $250,000 BPO, then a $200,000 listing price), the lender will start price reductions of $15,000 to $20,000 and do it three or four times. So after 6 months on the market the offering price may have been dropped to $200,000 - $15,000 - $20,000 - $15,000 - $10,000 = $140,000.

If the property still has not had any interest from buyers, the next stage is to drop the offering price to some ridiculous price, say $75,000. The process I will be describing here works especially well on distressed properties but works for any priced property as well. Many wholesale real estate investors look for REO's in the MLS every day and search for "New Listings" with offering prices below certain amounts, such as $100,000. What pops up is the new listing for the above property that is such a great deal that it really attracts investors to submit a contract on the property.

This is when the fun starts because the lender/realtor never really expected to sell at the offering price anyway!
Investors begin calling the realtor thinking they will be buying the property for $75,000 and are met with a standard answer "Submit your best offer because the lender is looking at other bids". This may or may not be true, but the realtor should never disclose the real information. Bids are accepted until no more are received, usually within 10 days. At this time the lender makes a decision on selling the property to the highest cash bidder or withdrawing it from the market.

This bidding process works very well to drive investors into a buying frenzy exactly what investors try to do to retail buyers for their rehabbed properties! Truly distressed properties are the target of investors and great deals can be had, but this "bait and switch" tactic works well for higher priced homes. Here is a recent example from a local realtor that was published in the Daily Business Review "Property was listed for $899K, then dropped to $839K, then $789K, $759K, and finally $599K which created a spike in buyers. The price was raised to $679K and the house is now under contract but the final price was not revealed."

Other issues with REO properties are excessive deposit requirements, closing agent requirements, onerous contract requirements, a limited warranty deed instead of a standard warranty deed, and working from an adversarial position with the realtor.

Even more interesting is one problem that I have had personally was when a realtor brought me a property that was an REO but he was not the listing agent. He explained that he would split the commission with the listing agent and it wouldn't cost me anything, which is one way to look at a realtor's commissions. I was told that a bid of $115,000 would buy the property. I submitted this bid with an authorization to go to $120,000 if necessary to buy the property. I agreed to a cash closing, submitted proof of funds in my bank, agreed to use the lender's closing agent, and wanted to close in 10 days. I was later told the lender accepted a higher bid, however, when I looked at the public records I saw that the winning bid was $110,000! Why, because the listing broker made 5% of $110,000 ($5,500) instead of 2.5% of $115,000 ($2,875). The lesson here is to use only the listing agent to submit your bids to the lender. So if you are an investor or a perspective homeowner looking to buy an REO, the old adage "Buyer Beware" was never more important
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